Business Basics: The Balance Sheet

The Balance Sheet

What is the Balance Sheet? Often referred to as a Statement of Financial Position, the Balance Sheet is just that — a detailed list of a business's assets (what it owns), liabilities (what it owes), and the value of the owners’ equity (or net worth of the business) at a specific point in time.

Assets are anything of value owned by the business including physical assets like plant and stock on hand, also funds in the bank and what is owed to the business by external parties.

Liabilities are debts owed to outside creditors or other parties — such as Accounts Payable to suppliers, PAYE, GST and Income Tax owing to the government and long-term liabilities owing to the bank and other external funders.

Owners’equity is the amount owed to the business owners – if everything was sold, funds collected and debts paid this is what is left for the owners.

The balance sheet gets its name from the way that the three major accounts (assets, liabilities and shareholders' equity) balance out.

Need help with your financial reports? Contact Engine Room Chartered Accountants in Tauranga and Pukekohe on 0800 236 446. 

Why is the Balance Sheet Important to Your Business? 

The balance sheet provides a picture of the financial health of a business at a given moment in time — usually at the end of a month or financial year. It can tell you if you owe more money than what you currently have, the current value of your assets and the overall value of your business.

The balance sheet can also provide you with warning signs which can allow you to solve any problems before they become major issues for your business.

The balance sheet is a vital financial statement that should be reviewed regularly as it changes with every transaction.

Balance Sheet Classifications

Assets and liabilities are classified further to help you monitor your financial position. They are both broken down into “current” and “non-current” to show how soon they must be turned into cash (assets) or repaid (liabilities).

Current refers to a period of less than twelve months, while non-current refers to a time period greater than twelve months.

Current Assets
Current assets are the items that you expect to turn in to cash within 12 months, they include Cash at the Bank, Stock on Hand, Work in Progress and Debtors or Accounts Receivable.

They fluctuate in value as you trade on a day-to-day basis, and in most businesses struggling with cash flow it is because stock, debtors and work in progress have got out of hand.

Non-Current Assets
These assets are split in to two categories — tangible and intangible.

Tangible assets are things that you can usually see and touch, such as equipment or office furniture.They are usually referred to as Fixed Assets.

A more formal definition is the "property or equipment that an entity owns that are primarily used for running the business."

A fixed asset is something that:
  • has a useful life of more than one year,
  • can't be claimed in full as a business expense in the year purchased (usually costing more than $500),
  • the cost can be claimed over the life of the asset (known as depreciation). 

Intangible assets can be even more important and valuable to a company. These assets are harder to measure and not necessarily something you can feel and touch such as a business's reputation, company know-how, industry knowledge and name recognition.

Intellectual property is a variation of an intangible asset, intellectual property includes trademarks, patents, brand names, logos, formulas, inventions and other creative communications.

Current Liabilities
Current liabilities are bills due within the next 12 months. These liabilities are usually paid by the collection of current assets, many within 30 days.

Examples of current liabilities are accounts payable, short-term bank loans, PAYE, GST, and accrued income taxes.

Since current liabilities are typically paid by from current assets, where current liabilities increase faster than current assets the business is likely to be unprofitable and struggling with cash flow.

A great target is to have current assets at twice the value of current liabilities if your business carries trading stock, or 1 ½ times if you are a service business. This calculation is called the "Current Ratio" – current assets/current liabilities.

Non-current Liabilities
Non-current liabilities (sometimes referred to as long-term liabilities) are debts of the business that are due beyond 12 months.

Examples are: finance leases, hire purchase agreements, mortgages and long-term loans.

These liabilities are classified separately in a business’s balance sheet, away from current liabilities.

Sometimes a business will purchase long term assets – such as plant and equipment, using short term liabilities — an overdraft or 30-day payments terms. This is a risk if you don’t have the funds in the bank (it is always better to finance long-term assets with long-term debt).

How Does the Balance Sheet & the Profit & Loss Statement Differ?

The Balance Sheet and Profit & Loss Statement are two of the three financial statements that businesses should review regularly.

Although the balance sheet and the profit and loss statement contain some of the same information there are important differences between the two of them which are:

The Role of Time
A major difference between the Balance Sheet and the Profit & Loss Statement involves their respective treatments of time.
The Balance Sheet summarises the financial position of a company at one specific point in time whereas the Profit & Loss Statement shows revenues and expenses over a set period of time.

Call us now on 0800 236 446 if you are ready to see how your business can improve.

Engine Room Chartered Accountants Tauranga & Pukekohe

If you are beginning to notice some worrying trends in your balance sheet, or if your business is in need of expert help, then contact the experienced and friendly team at Engine Room Chartered Accountants Tauranga and Pukekohe.

At Engine Room we take pride in providing high-quality Business Coaching, Financial Management and Accounting Services in a professional and down-to-earth manner.

Great business performance starts here.

Contact us through our website or call us today on 0800 236 446 for a no obligation chat and see how we can improve your business's financial efficiency.